Chapter  2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 1 ACCOUNTING FOR LEASES LEARNING OUTCOMES:  TO ACCOUNT FOR LEASES 8

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 2 KEY TERMS  amortisation  economic life of the asset  executory costs  fair value  finance lease  guaranteed residual value  inception of the lease  interest rate implicit in the lease  lease  lease commitments

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 3 KEY TERMS  lease term  lessor  lessee  minimum lease payments  non-cancellable lease  operating lease  residual value  sale and lease-back transactions  useful life of leased property

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 4 FEATURES OF LEASES  Term of the lease  Periodic rental payments  Guaranteed residual value  Useful life of the leased asset  Options at the end of the lease

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 5 FEATURES OF LEASES  TERM OF THE LEASE ÙAccounting standard covers leasing arrangements in excess of 12 months ÙBasic lease conditions determined by economic life of the asset

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 6 FEATURES OF LEASES  PERIODIC RENTAL PAYMENTS ÙLessee is obliged to make periodic payments ÙPayments usually made in advance ÙPayments calculated to return ‘fair value’ to lessor ÙPayments provide predetermined return on investment in the asset ÙPayments may be increased to cover costs of maintenance, insurance, other operational costs

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 7 PARTS OF PERIODIC RENTAL PAYMENTS LEASE Repayment of principal amount Payment to meet interest obligations

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 8 FEATURES OF LEASES  GUARANTEED RESIDUAL VALUE ÙTotal rental payments calculated on the difference between the cost of the asset plus financial charges and estimated residual value of the asset at the end of the lease term ÙAt the end of the lease term lessee may be required to pay difference between the amount realised and the guaranteed residual value ÙSome lease agreements allow asset to be purchased by lessee at the residual value

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 9 FEATURES OF LEASES  USEFUL LIFE OF THE LEASED ASSET ÙUseful life is the term of the lease if the lessee does not intend to purchase ÙUseful life is the period the lessee expects to benefit from using the asset if the lessee intends to purchase

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 10 FEATURES OF LEASES  OPTIONS AT THE END OF THE LEASE ÙArrange a lease-back for further term ÙArrange trade-in of item with lessor’s permission and negotiate further lease on new asset ÙBuy asset from lessor at residual value ÙReturn asset to lessor

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 11 TYPES OF LEASES  FINANCE LEASES ÙRisks and benefits incidental to ownership of asset go to lessee ÙLease must be non-cancellable ÙTerm of lease must be at least 75% of usual life of asset, or payment must be equivalent to 90% of fair value of asset ÙLease contains a bargain option for lessee to buy leased asset

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 12 TYPES OF LEASES  FINANCE LEASES ÙOther types of financial leases : xsales-type lease xleveraged lease xdirect financing lease

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 13 NON-CANCELLABLE? SUMMARY OF FINANCE LEASE RISKS & BENEFITS TRANSFERRED? LEASE TERM 75% USEFUL LIFE? LEASE PAYMENT 90% OF FAIR VALUE? FINANCE LEASE YES OPERATING LEASE NO BARGAIN OPTION AVAILABLE?

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 14 TYPES OF LEASES  OPERATING LEASES ÙRisks and benefits of ownership of asset are retained by lessor ÙLessee’s payments considered to be rental rather than recovery of asset costs ÙLease is usually cancellable ÙUsually shorter term than financial leases ÙRental is usually only small part of useful economic life of leased asset

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 15 AMORTISATION  Has similarities to depreciation for non- current assets ÙAmortisation based on the useful life of the asset if lessee is able to acquire the leased asset ÙAmortisation based on the life of the lease if lessee is not able to acquire the leased asset

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 16 ADVANTAGES OF LEASING  Funds may be freed for other uses  No need for loans for ‘debt finance’  Credit avenue preserved for future use  Useful for assets that may have obsolescence e.g. computing equipment

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 17 ADVANTAGES OF LEASING  Can be a hedge against inflation  Capital conserved  Tax advantages  Business can have latest available technology  Avoids having to dispose of asset

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 18 DISADVANTAGES OF LEASING  No prestige of ownership with leased asset  Equipment may become obsolete during lease term  Potential loss if residual value is less than agreed amount  Lease costs generally higher than borrowings  No capital gains for assets such as land and buildings

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 19 SCHEDULE OF LEASE PAYMENTS  Accounting standard requires schedule to be prepared for financial lease to show apportionment of lease payments

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 20 LEASE SCHEDULE Illustration 8B (page 214)

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 21 DISCLOSURE REQUIREMENTS  AASB 1008 and the Corporations Law require information relating to finance leases to be included: Ùat the foot of the Statement of Financial Performance Ùand also on the Statement of Financial Position

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 22 DISCLOSURE REQUIREMENTS  STATEMENT OF FINANCIAL PERFORMANCE SHOULD CONTAIN: Ùamount of amortisation of the leased asset Ùthe interest expense for the year

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 23 DISCLOSURE REQUIREMENTS  STATEMENT OF FINANCIAL POSITION SHOULD CONTAIN: Ùoriginal value of leased asset with accumulated amortisation shown as deduction Ùlease liabilities classified into current and non-current elements Ùlease commitments outstanding, reconciled with lease liability and classified ( see notes ) Ùfuture finance charges (interest not paid) deducted from total commitments, to reconcile with total of current and non-current liabilities

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 24 LEASE NOTES TO ACCOUNTS Illustration 8E (page 218)

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 25 ACCOUNTING ENTRIES  An operating lease is similar to a rental agreement  Lessee pays the lessor rental payments that are recorded as expenses by the lessee DateDetailsDebitCredit 31.05Rental expense (lease)$xxx Cash at bank$xxx Lease payment

 2003 McGraw-Hill Australia Pty Ltd, PPTs t/a Applications for Financial Accounting by David Willis, slides prepared by Kaye Watson 26 CANCELLING A LEASE  Cancelling depends on: Ù terms of lease agreement Ù whether lessor approves Ù financial penalties